In this paper, we investigate the optimal supplier’s and buyer’s reactions to supply disruption. Upon disruption, the supplier loses the supply during the recovery period. Given a delivery time contract between the supplier and buyer, the supplier can make an investment to decrease the recovery time to benefit both parties. If the supplier’s capacity is recovered after the delivery time, the supplier should pay a penalty cost to the buyer for each unit of lost sale demand and for the amount of time that the supply is delayed. Also, similar to the supplier situation, the buyer incurs a penalty cost for each unit of lost sale demand and for the amount of the waiting time.

Because the supplier can decrease the recovery completion time, the buyer may offer a financial subsidy incentive to the supplier (sole sourcing with a financial subsidy incentive strategy) or source from two suppliers (dual sourcing strategy). In this study, we present two Stackelberg game models to highlight optimal buyer’s and supplier’s decisions under the mentioned strategies We also find the financial incentives levels that would coordinate the two-party supply chain. Finally, we compare the two strategies and characterize the buyer’s preference as a function of the model parameters.

Our work complements literature papers where they analyzed similar problems in the context of improving the suppliers’ reliability so as to reduce their chances of being disrupted. In contrast, we focus on the analysis of disruption recovery strategies. In particular, we investigate the role of building long term supplier relationships, through joint investment programs, in mitigating the impact of supply disruptions.